Korea Outlook: North Korea Attack, Economic Data to Move KOSPI

In this first of a new series focused on market moving financial and economic news, with regard to the Republic of Korea, we would like to extend a special request to readers for feedback regarding this report. Honesty and candor will be appreciated, as we try to get an understanding of what readers hope to gain from this report.

Danger on the Yellow and Aegean Seas

Geopolitical factors at home and abroad are busy pulling Korean equity indexes to levels not seen since February 26, 2010, when the KOSPI had last touched 1,600, since again touching that level on Thursday May 20, 2010.

The Joint Civilian-Military Investigation Group (JIG), which includes 24 foreign experts from the United States, Britain, Australia and Sweden, announced a North Korean Midget Submarine Torpedoed the Cheonan [S. Korean warship] at night [on March 26, 2010, in the Yellow Sea]." -The Korea Times

The issue had remained somewhat of a mystery, despite unofficial reports that a North Korean torpedo had sunk the Cheonan, thus causing the deaths of 46 South Korean sailors. The attack directly violated the Armistice Agreement signed in 1953, which defined a ceasefire that has kept the two countries from direct combat for 57 years. Still, official statements from Pyongyang (the North Korean Capital) have denied involvement in the incident, and instead "consider the current situation a state of war" provoked by the South. Most of the international community side with the South as leaders carefully measure responsive actions, however China's indecisive stance has amplified foreign concerns. Markets sold off on Thursday, on increased risk of an escalating conflict on the peninsula, while trading on Friday was cancelled due to the celebration of Buddha's birthday.

In the far away Aegean Sea surrounding Greece, very different forces have led to similarly negative market influence over the past few weeks. The effects of destabilized Greek sovereign financing have already spread to all corners of the European Union nations, but could soon escape the continent to other corners of the globe.

The yield on medium term Korean sovereign debt had been dropping as confidence in the government and stabilizing economic recovery brought the value of both Korean debt and the Korean Won higher for the first four months of 2010.

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KRW/USD vs. Korea 3-Year Bond Yield

However, as of the beginning of May, the daily market yield on the 3-year Korea bond, and the value of the U.S. Dollar/Korean Won has risen significantly. We believe that a substantial degree of the bottoming of Korean Government debt yields can be attributed to the contagion effect out of Greece, where the financial solvency of governments across the globe have been called into question.

On Wednesday and Thursday of last week, the KRW sold-off even more significantly, compared to the USD, as the Cheonnam torpedo attack became official and inter-governmental tensions on the Korean peninsula escalated.

Econ Data

Beginning on Monday at 12:00 pm, the report of Loans and Discounts of Depository Institutions (by industry) will be released for Q1 2010. The last report (Q4 2009) showed a slowing in the pace of overall loan growth in Korea, as financing to industry players dropped by -1.0%, while consumer financing still grew at 2.2%, putting the headline loan growth at 0.4% compared to 1.8% in Q3.

On Tuesday we'll get the 2010 Q1 Korea International Investment Positionreport at 12:00 pm, where the previous report for Q4 2009 announced a full year 2009 Net International Investment Position (IIP) equating to -35.0 billion USD, with a change of +9.4 billion USD in 2009 Q4. The negative IIP was attributed to large inflows of foreign funds into Korean equities, as foreign investment portfolios increased exposure to Korean corporations, and as the amount of Korea's long term external debt increased by +24.0 billion USD in 2009 (+4.5 billion USD in Q4). Investors will be watching to see if this influx of investment in the Korean stock market and Korean sovereign debt has continued through Q1 of 2010.

Wednesday we'll see the Consumer Survey Index (CSI) for May 2010 and Household Credit Trends Report for Q1 2010. First we'll see the CSI at 6:00 am, and its headline Composite Consumer Sentiment Index (CCSI) which has held at the 110 level for the past two months. Investors will be looking for a change in the CCSI and also the expectations for changes in Household Income and the Domestic Economic Situation, which have both trended lower to 101 and 100 respectively. Next at 12:00 pm the Household Credit Trend report will be closely watched for a trend to form in March, following January and February's -1.0% and 0.8% changes.

Thursday's economic data will come in the form of the Balance of Payments Report for April 2010. The balance of payments is essentially the national statement of cash flows for a nation, where all monetary transactions are recorded. This report will be especially important to Korean investors and monetary policy officials, since the crucial Current Account portion of the Balance of Payments has recently trended towards a "net zero" reading.

The Current Account will be closely watched for signs that the return to a surplus in February 2010 is the beginning of a trend towards higher surpluses in the future. In March the Current Account surplus grew from 0.17 billion to 1.69 billion USD on an increase of net exports of goods and services.

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Korea Current Account - January 2008 to February 2010

According to the China Post, Korea held $273.3 billion, the sixth largest reserve of USD currency behind China, Japan, Russia, Taiwan and India at the end of January 2010. The high level of foreign reserves has been explained by the Korean Central bank as its best means to fend off a currency crisis, but has come under criticism as the current account surplus swung to a deficit in January 2010.

On Friday markets will be faced with the May 2010 Business Survey Index (BSI) Report at 6:00 am and the April Weighted Average Interest RateReport at 12:00 pm. The BSI manufacturing index for April rose from 99 to 103, while the non-manufacturing report also rose, from 86 to 90. However, when adjusted for seasonality, manufacturing sentiment remained unchanged and non-manufacturing declined by 4 points. Readings from the BSI are sure to be matched with readings from the Current Account report as investors look for a trend of business activity moving forward.

The average interest rate on deposits at financial institutions increased only 0.01% in March to 3.19%, and the average rate for loans dropped 0.01% to 5.93%. The average spread for financial institutions can then be inferred at 2.74%, as both the costs of financing and the profit from issuing loans by banks has stabilized in recent months.

Looking to the week ahead, many questions regarding the strength of Korea's economy from the stance of consumers, businesses, and international investors will become much clearer through the aforementioned econ data. However, the KOSPI Korean equity index, the Korean Won, and yields on Korean debt will continue to be heavily influenced by geopolitical factors surrounding the conflict with North Korea and developments in global financial markets, resulting from sovereign default risks in Europe.

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